The city gravy train and procurement

Chris Blackhurst (October16th) in the Evening Standard wrote about the City gravy train and blamed the customers of city firms for allowing huge profits and bonuses through their own lack of care about the fees they pay. While some City income comes from firms trading with their own money, he is right to identify the problem; that their clients don’t do a good enough job in buying those services. And he asked why a “company chairman may agree to pay £100 million for assistance on a takeover”. Easy, Chris said, “it's not his £100 million.”

But it can’t be as simple as that. It’s not the chairman’s money, or the MD’s money, or the regional manager’s money, when the company buys all sorts of other services. Transport; contract cleaning or security; temporary agency staff; fleet management; recruitment services; advertising; IT services...the list is endless. So why doesn’t the company throw their shareholders’ money at suppliers of these services? Because they certainly don’t - we don’t see the service providers in these industries taking home million pound bonuses year after year. So why is that?

In most companies, it is because the chairman and the Board don’t get the chance to throw the money around. Any substantial organisation, private and public sector, has a buying, (or procurement, or purchasing) department. They will make the decision on choosing suppliers, or at least have a major input, and will make sure that a competitive process is used. This means that, through competition, the best suppliers are chosen, and the organisation pays a fair, market price for the services they receive. Competition is a wonderful thing! And it is not always the cheapest supplier chosen ; quality and other factors can be taken into account. But the aspects of fairness and competition lie at the heart of good corporate purchasing.

We can see the effect this can have. In June, Martin Sorrell of WPP blamed the increasing involvement of clients’ procurement functions for a more ‘aggressive’ approach to contract negotiation, which resulted in the world’s largest advertising agency missing profit margin expectations. Well done, procurement people, we should say, for keeping the world’s largest marketing agency on its toes!

But...this just does not happen with too many ‘City’ type services. It is beginning to get more common in areas such as management consulting and legal services, and professional purchasing is beginning to have an effect here. Incomes for partners have fallen over the last two years dramatically in most firms; mainly linked to the recession, but purchasing is having an impact. “I’m having to respond to at least one formal tender a week now”, a senior partner in a top ten law firm told me recently. “That just wasn’t happening even 2 or 3 years ago”.

But investment banking, the real top-level consulting and legal advice, fund management, trading and so on are still very much off limits to purchasing people. To be fair, there are reasons why these services can’t be treated like cleaning or transport. There often isn’t time to hold a full competitive tendering process before appointing an investment bank to defend a takeover bid. Confidentiality is also a real problem; you are hardly likely to advertise in the FT that you need advice on a major financial re-structuring. These are genuine reasons. And purchasing staff have not had much experience in this area – they may feel intimidated and diffident about trying to take on the masters of the universe. Steve or Karen from Corporate Buying (on £35K a year), facing up to negotiate with Hugo or Caroline from Goldman’s (on £5 million)? Not a fair fight!

But that doesn’t mean organisations shouldn’t try and do the right thing, or that some proper competition can’t be introduced.

Let’s assume we have just received a takeover bid. We call our favourite investment bank and ask for help. We agree what we need, and add as an afterthought “oh, and you better send me a letter laying out your terms”.

A week later we get the letter; the partner at £1000 an hour, or perhaps a fixed fee of £50 million for pretty unspecified services. The clock is ticking – we might have spent a million or two already. Now consider a different approach. We call three firms and ask for a proposal by close of business today, (it is urgent after all) for them to work on our defence. We ask for their rates, both hourly for named people and some fixed rates for certain services. Perhaps we ask for some references.

How different do you think their prices will be compared to the first example? 20% lower? 30%? 50%? I don’t know, but it will represent much better value than I can possibly get through the first scenario.

So why don’t chairmen act in this way it? It is partly the genuine concerns around time and confidentiality, and also their belief that they must have the firm or people they believe are ‘the best’. Fair enough, except their definition of ‘the best’ often means nothing more than they’ve worked with them before, or they play golf together. Then there is what we could define uncharitably as corruption. The trips to Wimbledon and Glyndebourne (or strip clubs at the younger end of the market), the Christmas hampers, the lucrative consulting assignment or non executive role offered with the bank once the chairman steps down...and this is not just chairmen, it is chief executives, fund managers, brokers..all in it together. All unethical, if not corrupt.

So what can we do? There are some concrete actions that could be taken; and this could be the start of our campaign, to be implemented through legislation or peer pressure. All organisations should be asked to state in their annual report (or to the FSA if they are regulated) that they follow these three “principles of open procurement” – and list the exceptions where they do not.

1. Organisations will have in place and publish their procurement policies and processes, which will be applied to all external expenditure, including spend that falls into this ‘City’ category.

2. Everyone in the organisation who is involved in spending money with suppliers will sign up to the Chartered Institute of Purchasing and Supply (CIPS) ethical code, as many buyers already do. The Code sensibly defines what is and is not acceptable around gifts, hospitality and so on. And no, hampers are not allowed.

3. All expenditure over a certain level – say £50,000 – will go through a competitive process before a contract is put in place (any exceptions to be listed in the annual report).

If this were implemented, I guarantee we would see a more dynamic City, rewards that reflected performance better; and perhaps more real opera lovers at Glyndebourne and cricket fans at Lords!

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